Principles of Microeconomics

class: center, middle, inverse, title-slide

.title[
# Principles of Microeconomics
]
.author[
### ECO 2306
]
.date[
### <em>Fall 2022</em>
]

---

class: center, middle, inverse

# Chapter 12:
## Firms in Perfectly Competitive Markets

---

## Market Structures and Perfect Competition

.panelset[

.panel[.panel-name[Introduction]

Recall the three questions every society must answer
1. What will we make?
2. How will we make it?
3. Who will receive it?

**market structures**: models of how the firms in a market interact with buyers to sell their output

In free market economies, we rely on private firms and markets to produce most of our goods and services

Each industry is unique, but can be grouped according to how it answers the following:
1. The number of firms in the industry
2. The similarity of the good or service produced by the firms in the industry
3. The ease with which new firms can enter the industry
]

.panel[.panel-name[The Big Four]
Each market structure will be applicable to different real-world markets and will give us insight into how firms in certain types of markets behave.

<table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;">
<caption style="font-size: initial !important;">Table: The Four Market Structures</caption>
 <thead>
  <tr>
   <th style="text-align:center;"> Characteristic </th>
   <th style="text-align:center;"> Perfect Competition </th>
   <th style="text-align:center;"> Monopolistic Competition </th>
   <th style="text-align:center;"> Oligopoly </th>
   <th style="text-align:center;"> Monopoly </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> Number of firms </td>
   <td style="text-align:center;"> Many </td>
   <td style="text-align:center;"> Many </td>
   <td style="text-align:center;"> Few </td>
   <td style="text-align:center;"> One </td>
  </tr>
  <tr>
   <td style="text-align:center;"> Type of product </td>
   <td style="text-align:center;"> Identical </td>
   <td style="text-align:center;"> Differentiated </td>
   <td style="text-align:center;"> Identical or differentiated </td>
   <td style="text-align:center;"> Unique </td>
  </tr>
  <tr>
   <td style="text-align:center;"> Ease of Entry </td>
   <td style="text-align:center;"> High </td>
   <td style="text-align:center;"> High </td>
   <td style="text-align:center;"> Low </td>
   <td style="text-align:center;"> Entry blocked </td>
  </tr>
  <tr>
   <td style="text-align:center;"> Examples of industries </td>
   <td style="text-align:center;"> Growing wheat<br>
               Poultry farming </td>
   <td style="text-align:center;"> Clothing stores<br> 
               Restaurants </td>
   <td style="text-align:center;"> Manuf. computers<br>
             Manuf. autos </td>
   <td style="text-align:center;"> First-class mail delivery<br>
              Providing tap water </td>
  </tr>
</tbody>
</table>
]
.panel[.panel-name[Perfect Competition Intro]
.pull-left[
Perfect competition is a market that meets the conditions of
1. many buyers/sellers
2. identical products
3. no barriers to entry

Points 1 and 2 imply **price-takers**
- buyers/sellers are unable to affect the market price
- firms are tiny relative to the market and sell exactly the same product as everyone else

If all firms in perfectly competitive markets are price takers,
then no one can raise the price of what they make without
quantity demanded going to zero
]
.pull-right[
<img src="data:image/png;base64,#images/fig_12_1.png" width="100%" style="display: block; margin: auto;" />
]
]
.panel[.panel-name[Firm Demand]
.pull-left[
Another way to think about perfectly competitive conditions:
1. full info on prices
2. identical products
3. low transaction and search costs

Perfectly elastic firm demand
- No matter what the firm's cost function is, the price is unchanged.
- Shifts in the cost function only affect the quantity sold, not the price.

]
.pull-right[
<img src="data:image/png;base64,#images/mit_7_1.png" width="100%" style="display: block; margin: auto;" />
]
]
.panel[.panel-name[Market Demand]
.pull-left[
Don't get the flat individual demand curve confused with the downward sloping market demand curve
- The downward sloping market demand curve sets the price
- The individual in a perfectly competitive market must take this price as given

There are thousands of individual wheat farmers
- Their collective supply, combined with the overall market demand for wheat, determines the market price of wheat in the first panel.
- The individual farmer takes this market price as his or her demand curve: the second panel.

Note: we're skipping a lot of math to derive this result.

]
.pull-right[
<img src="data:image/png;base64,#images/fig_12_2.png" width="100%" style="display: block; margin: auto;" />
]
]

]

---

## Profit Maximization Under Perfect Competition
.panelset[

.panel[.panel-name[Intro to Profit]
.pull-left[
Perfectly competitive firms seek to maximize profit

$$
`\begin{aligned}
Profit &= TR-TC \\
&= P*Q - FC - VC
\end{aligned}`
$$

Average revenue

$$ 
`\begin{aligned}
AR &= \frac{TR}{Q} \\
&= \frac{P*Q}{Q} = P
\end{aligned}`
$$

Marginal revenue

$$
MR = \frac{\Delta TR}{\Delta Q} = P
$$

]
.pull-right[
<table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;">
<caption style="font-size: initial !important;">Table: Example Farmer's Revenue from Wheat Production</caption>
 <thead>
  <tr>
   <th style="text-align:center;"> Quantity </th>
   <th style="text-align:center;"> Price </th>
   <th style="text-align:center;"> Total Revenue </th>
   <th style="text-align:center;"> Average Revenue </th>
   <th style="text-align:center;"> Marginal Revenue </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> NaN </td>
   <td style="text-align:center;"> NA </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 14 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 21 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 28 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 35 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 42 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 49 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 8 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 56 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 9 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 63 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 70 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
  </tr>
</tbody>
</table>

]
]
.panel[.panel-name[Profit Table]

<table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;">
<caption style="font-size: initial !important;">Table: Example Farmer's Profits from Wheat Production</caption>
 <thead>
  <tr>
   <th style="text-align:center;"> Quantity </th>
   <th style="text-align:center;"> Price </th>
   <th style="text-align:center;"> Total Revenue </th>
   <th style="text-align:center;"> Average Revenue </th>
   <th style="text-align:center;"> Marginal Revenue </th>
   <th style="text-align:center;"> Total Cost </th>
   <th style="text-align:center;"> Marginal Cost </th>
   <th style="text-align:center;"> Profit </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> NaN </td>
   <td style="text-align:center;"> NA </td>
   <td style="text-align:center;"> 10.0 </td>
   <td style="text-align:center;"> NA </td>
   <td style="text-align:center;"> -10.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 14.0 </td>
   <td style="text-align:center;"> 4.0 </td>
   <td style="text-align:center;"> -7.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 14 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 16.5 </td>
   <td style="text-align:center;"> 2.5 </td>
   <td style="text-align:center;"> -2.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 21 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 18.5 </td>
   <td style="text-align:center;"> 2.0 </td>
   <td style="text-align:center;"> 2.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 28 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 21.0 </td>
   <td style="text-align:center;"> 2.5 </td>
   <td style="text-align:center;"> 7.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 35 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 24.5 </td>
   <td style="text-align:center;"> 3.5 </td>
   <td style="text-align:center;"> 10.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 42 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 29.0 </td>
   <td style="text-align:center;"> 4.5 </td>
   <td style="text-align:center;"> 13.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 7 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 7 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 49 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 7 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 7 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 35.5 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 6.5 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 13.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 8 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 56 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 44.5 </td>
   <td style="text-align:center;"> 9.0 </td>
   <td style="text-align:center;"> 11.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 9 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 63 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 56.5 </td>
   <td style="text-align:center;"> 12.0 </td>
   <td style="text-align:center;"> 6.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 70 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 72.0 </td>
   <td style="text-align:center;"> 15.5 </td>
   <td style="text-align:center;"> -2.0 </td>
  </tr>
</tbody>
</table>

]

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]

.panel[.panel-name[Rules]
.pull-left[

Profit is maximized when
1. The difference between total revenue and total cost is as large as it will ever be `$(Profit = TR - TC)$`, and
2. Marginal revenue equals marginal cost `$(MR=MC)$`

Rules 1. and 2. don't require perfect competition; they are true for every firm!

For perfectly competitive firms, `$P = MR$`; this implies:

3. The profit-maximizing level of output is also where `$P = MC$`.

]
.pull-right[
We can illustrate profit graphically by decomposing it into other functions

$$
`\begin{aligned}
Profit &= TR - TC\\
Profit &= PQ - TC\\
\frac{Profit}{Q} &= \frac{PQ}{Q} - \frac{TC}{Q}\\
\frac{Profit}{Q} &= P - ATC\\
Profit &= Q*(P-ATC)
\end{aligned}`
$$
]
]
.panel[.panel-name[Profit]
<img src="data:image/png;base64,#images/fig_12_4.png" width="60%" style="display: block; margin: auto;" />
]

.panel[.panel-name[Breakeven]
<img src="data:image/png;base64,#images/fig_12_5.png" width="60%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Loss]
<img src="data:image/png;base64,#images/fig_12_5b.png" width="60%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Profit Summary]
Once we have determined the quantity where `$MC = MR$`, 
- we can immediately know whether the firm is making a 
  - *profit*, 
  - *breaking even*, or 
  - making a *loss*.

At that quantity,
- If P > ATC, the firm is making a profit
- If P = ATC, the firm is breaking even
- If P < ATC, the firm is making a loss

Even better: these statements hold true at every level of output.

]
]

---

## Produce or Shut Down

.panelset[
.panel[.panel-name[Introduction]
Suppose a firm in a perfectly competitive market is making a loss. It would like the price to be higher, but it is a price-taker, so it cannot raise the price.

That leaves two options:
1. Continue to produce, or
2. Stop production by shutting down temporarily

Recall, short-run implies **fixed costs**
- Fixed costs should be ignored because they are **sunk costs** 
- **Sunk costs**
  - costs that have already been paid and cannot be recovered
  - even if they haven’t literally been paid yet, the firm is still obliged to pay them

The firm needs to decide whether to incur only its fixed costs or to produce and incur some variable costs, but also obtain some revenue

]
.panel[.panel-name[Shut-down condition]
Firms's choose to shut down when the profits of producing are *less than* the profits from shutting down.

Shutdown condition:
.pull-left[
$$
`\begin{align}
Profit_{producing} &< Profit_{shutdown}\\
TR_{prod} - TC_{prod} &< TR_{sd} - TC_{sd}\\
P*Q_{prod} - FC_{prod} - VC_{prod} &< P*Q_{sd} - FC_{sd} - VC_{sd}\\
P*Q - FC - VC &< 0 - FC - 0\\
P*Q - FC + FC &< 0 + VC\\
P*Q &< VC\\
\\
\fbox{P < AVC}
\end{align}`
$$
]
.pull-right[
So, if `$P < A VC$`, the firm should produce 0 units of output

If `$P>=AVC$`, then the `$MC = MR$` rule guides production; for a perfectly competitive firm, this means where `$MC = P$`.

So, the marginal cost curve gives us the relationship between price and quantity supplied: it is the **firm’s supply curve**!

]
]
.panel[.panel-name[Supply Curve 1]
<img src="data:image/png;base64,#images/fig_12_6a.png" width="60%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Supply Curve 2]
<img src="data:image/png;base64,#images/fig_12_6b.jpg" width="60%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Firm vs. Market]
<img src="data:image/png;base64,#images/fig_12_7.png" width="100%" style="display: block; margin: auto;" />
]
]

---

## Long Run
.panelset[
.panel[.panel-name[Introduction]

The definition of the long run is that all access to and variation in inputs is possible including new firms acquiring the necessary inputs to enter the market and existing firms liquidating their inputs and leaving the market

Economic profit is a firm's revenue minus all its costs, including its implicit costs

- This includes foregone salaries and opportunity cost of capital
  
  - What do you think should happen if a firm is earning profits in the long run? Why?
]
.panel[.panel-name[Example]
Sacha Gillette starts a small cage-free egg farm.

Sacha's **economic profit**, her revenues minus all of her costs, both implicit and explicit, is $60,000.

Additional firms will enter the market, attracted by the profit. Perhaps:
- Some farms will switch from other products to cage-free eggs, or
- People will open new farms.

However it happens, the number of firms in the market will increase, increasing supply; this will in turn lower the price Sacha can receive for her output.

]
.panel[.panel-name[Entry]
<img src="data:image/png;base64,#images/fig_12_8.png" width="80%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Exit 1]
<img src="data:image/png;base64,#images/fig_12_9a.png" width="70%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Exit 2]
<img src="data:image/png;base64,#images/fig_12_9b.png" width="65%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Equilibrium]
<img src="data:image/png;base64,#images/fig_12_10.png" width="65%" style="display: block; margin: auto;" />
]
.panel[.panel-name[Efficiency]
We have shown that in the long run, 
- perfectly competitive markets are **productively efficient**
- This implies that the marginal firm is operating at the lowest point on its average total cost curve
- **Productive efficiency** is the situation in which a good or service is produced at the lowest possible cost

But they are **allocatively efficient** also
  - The price of a good represents the `$MB$` consumers receive from consuming the last unit of the good sold.
  - Perfectly competitive firms produce up to the point where the `$P = MC$`
  - Therefore, firms produce up to the point where the last unit provides a `$MB$` to consumers equal to the `$MC$` of producing it.
  - **Allocative efficiency**: a state of the economy in which production represents consumer preferences--in particular where `$MC = MB$`
  
Productive and allocative efficiency are useful benchmarks against which to measure the actual performance of other markets.
]
]

---